ORSA and Independent Review - Misunder-stud?

Independent review of ORSA
- banging the drum?

I listened in on a Solvency II readiness webcast a couple of weeks ago which pricked my ears like a low-budget high street beauty parlour. The specific theme was independent review of ORSA, and the broadcaster confidently included it in the list of "things we all need to do" in the Solvency II preparatory phase, both 2014 and 2015.

While most familiar with the topic would immediately cry "that got lobbied out in 2011", the speaker's argument was that, while EIOPA's Guidance no longer says firms should "independently" review its ORSA, it also doesn't not say it, therefore we must do it, and do it annually!

I would have chuckled and left it at that, but having read InsuranceERM's recent roundtable on preparations for Solvency II, the topic again reared its head, albeit in a more controlled manner, as a number of attendees explained how they have used Internal Audit (and dismissed the idea of using external firms) in reviewing their ORSA processes during the preparatory phase.

My problem is this - as an industry we were happy to, erm, relieve ourselves and moan when CEIOPS's first attempts at ORSA Guidance in 2010 included a guideline which compelled annual independent review of the ORSA Process (included in slide 32 of Mr Bernadino's pack here in Summer 2011, as I can't find the original CP anywhere).

This was lobbied-out by the time the re-badged EIOPA released their 2011 CP (here), and when their Final Report followed in June 2012, "independent review" was a distant memory.

Any compulsion to review the ORSA Process is now  covered only by EIOPA's System of Governance Guidelines (here), specifically Guideline 8 asking that a firm's SoG is regularly "internally reviewed on a regular basis" (5.11).

EIOPA continue in 5.11 that "...the review undertaken by the internal audit function on the system of governance as part of its responsibilities can provide input to this internal review" - i.e. this is not work considered to be performed automatically and exclusively by one's Internal Audit function.

In terms of frequency, EIOPA elaborate in section 4.26 of the Guidelines, namely that your AMSB, given your firm's nature, scale and complexity;

...determines the scope and frequency of the internal reviews of the system of governance

 So three things - no 'annual' requirement; AMSB's choice on frequency; and that this is internal review, not "independent", "external", or indeed any other word which gets me contracted past 2016!

InsuranceERM's Roundtable on Solvency II - extracting value and meeting challenges

InsuranceERM have kindly taken their pay barrier off the outputs of the Roundtable they hosted with Deloitte, bringing some of the talking heads we know and love and discussing the challenges of Solvency II, as well as the struggle to extract value from the project.

I thought the following was worthy of comment (too much effort to attibute to each commentator, so read the article if something tickles your fancy!);

From the value section;

• Suggestion that small/medium sized insurers required "education" on risk management to attain the awareness and levels of larger firms (patronising but fair?)
• Comment tha "documentation probably isn't as good as it should be" - the FSA would certain concur, based on their speech last month, and indeed the deal they cut with Lloyds last week.
• All references to ORSA centre on the ORSA Report/"Record of the ORSA Process", rather than the process itself. This is very natural (I fight it on a daily basis), but if it is a continuous assessment process, then we must redouble our efforts to talk of it as such, and not as a reporting process.
• Strange comment that non-executive directors feel they are being asked to do too much ("act like executive directors"). Appreciating this is a once-in a career suite of legislative activity, it's not that bad for a few days work, get on with it!
• Big statement made about Boards having internal model knowledge "before Solvency II came in" - I suspect the depth and breadth of what the Board needs to know about their models will be one of the hardest knowledge gaps to bridge for the 70-odd model applicants, so surprised to hear someone so dismissive.
• On Risk Appetite, a comment that ORSA is "forcing boards to actually reflect and achieve concensus around risk appetite" (which I would be mortified if Boards didn't already do), followed by a mention of monitoring "unused risk-bearing capacity" in one's risk profile, which I really like.
• One guy notes that UK capital requirements are not driven by regulatory capital, but rather ratings agency capital (or economic capital/overall solvency needs by another name) - while its a big statement, it is probably fair, bearing in mind where the big boys have calibrated their EC measures (all at or around AA - coincidence?).
• Quite a disappointing section on diversification benefits, which pretty much touched on M&A, and not much else

From the challenges section;

• Beautifully timetabled comment regarding the FSA and Lloyds "not delaying their timetables" - obviously didn't get the inside track on that one!
• One personal concern tabled that "given the level of resources in the FSA, the tier-one approval process may well drag out longer" - obviously DID get the inside track!
• "Many UK firms are targeting IMAP in the fourth quarter of this year" - so now we know?
• Guarded comment about regulators needing to be open and honest "about the basis and whether reliefs and concessions are going to be extended" regarding IMAP.
• Good comment regarding contingency plans for failed model applications - "capital loadings will come into play, rather than having to revert back to a standard formula", which is easy to forget when constructing said plans
• Another less well trodden discussion regardin the FSA compelling an organisation without resource to use an internal model - not certain of likelihood, but always good to be reminded of the Standard Formula not being a safety blanket in that respect.
• Nice piece on difficulties for groups, with "parents and subsidiaries running at different speeds depending on where they are located", followed on by regulatory arbitrage comment - is the FSA effective enough to coax the less well armed regulators to work at their speed?
• One commentator with a US presence noted he is participating lobbying the NAIC on ORSA and its value (it would certainly help the equivalence argument no end if they could get that one to stick, and it's already going well).
• Ends with one of my pet peeves, the CRO/Actuary debate - one commentator nails it with the CROs needing to be "broad-based business leaders with a high level of financial literacy", as opposed to an actuary, while another commends the "wave" of actuarial CROs, but is generous enough to say he can see it "broadening out a little bit" - thanks pal!

More excellent Solvency II materials

"Reassuring expensive" - not a bottle of Stella Artois, but subscription to InsuranceERM, who continue to produce cracking material to help validate your Solvency II approach on all three pillars. I picked out the following from last week (sign up for trial to view if you don't subscribe).

Dutch problems under Solvency II - Fitch ratings provide the research this time on Dutch preparedness for Solvency II. It highlights a couple of items; that AEGON and ING will be praying for the USA equivalence assessment to be successful (both of course have received state help on the capital front recently, so will be light on that front), and that secondly there would be a maximum of 12 Internal Model applicants, and potentially even less, due to resource scarcity.

CRO at Torus on his Solvency II approach - As a new company, he notes that the benefits of not having to incorporate legacy systems into the data warehouse is somewhat negated by the lack of historical data in producing the calculation kernel (relying on a deterministic approach in some areas). Very interested to see his approach to addressing the use test, which is by performing gap analysis between current and future state in 12 areas where model output could potentially be used.

Solvency II Balance Sheet volatility challenges - succinctly lists responses to the volatility expected when performing market consistent valuation as "raise capital, hedge, or change product lines". While UK already values in market consistent manner under IFRS, this will introduce SCR volatility across the continent. Makes a nice distinction between short and long term liabilities, and the ease of capitalising the former with reduced spread risk. Also suggests that asset-liability matching will become a more exact science across the board.